Will Europe Take America Down?

You should—and shouldn't—worry about the Greek debt crisis.

It's difficult to get comfortable with this recovery, isn't it? In April, the economy finally started to create jobs at a decent pace. But now problems in Europe, some of which are eerily reminiscent of the credit debacle that laid the United States low in 2008, are threatening to tank U.S. stock markets and the economy at large. While there's reason to be concerned, there's little reason to panic. The troubles in Europe bring some short-term good news for the United States—and not just the humbling of French President Nicolas Sarkozy, who as recently as January prattled on about the demise of U.S. economic leadership. And there is some potential bad news.

The trouble in Europe started in the government bond markets. As deficits and funding demands mounted, Greece, Spain, and Portugal lost the confidence of investors. Credit markets suddenly ceased to believe that these nations could get their financial houses in order. In exchange for assistance from the European Central Bank and the International Monetary Fund, Greece agreed to cut spending and raise taxes. Spain and Portugal are following suit. The ECB is running an expansionary monetary policy, but many of the European Union's member states are now running seriously contractionary fiscal policies. The result: Economic growth in continental Europe just hit a wall.

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Growth slamming to a halt in Europe is bad news for the stocks of European companies and for the global economy. Europe consumes an awful lot of goods and services, many of them imported. But it has upside for Americans. One of the first market responses to the growth slowdown in Europe has been a sharp drop in the price of crude oil, off about 20 percent in the past month. Kelly Evans reported in the Wall Street Journal on Tuesday that "a $10-per-barrel drop in prices could save [American] households about $20 billion per year in energy costs." (White House economic adviser Larry Summers, I got your mini-stimulus right here.) As usual during a periods of stress, investors around the world rushed to buy U.S. government bonds—a move that pushes interest rates down. In the past several weeks, the yield on the 10-year U.S. government bond has fallen from about 4 percent to 3.16 percent. Mortgage rates have followed suit. The dollar strengthening against the euro is good news for aficionados of Brunello di Montalcino and camembert, and for tourists. Now the bad news. A stronger dollar and weaker European demand will hurt exports, which have been a bright spot for the recovering U.S. economy, up 21.6 percent between March 2009 and April 2010. As the most recent report on the balance of trade shows, about 23 percent of U.S. exports go to Europe (see Page 19) and about 19 percent go to members of the European Union. The crisis in Europe is bad for American companies that ship their output across the Atlantic and whose goods have to compete with suddenly cheaper European goods.

The threat to America's real economy posed by Europe's travails is manageable. It's the threat to the nation's financial economy, which can then quickly spill over into the real economy, that bears watching. As Reuters reported, "Goldman Sachs estimated total U.S. bank exposure to Greek, Portuguese and Spanish debt at $90 billion." That's not a huge amount for big U.S. financial institutions.

But the danger is that we could see a repeat of the influenza epidemic of 1918, which spread from a chaotic Europe and infected and killed millions of Americans. Panic, fear, and a crisis of belief is today's influenza: a lethal airborne virus that spreads rapidly. If European credit and bank markets break down, and if Europe gets gripped by the same crisis of confidence that affected the U.S. financial system in the fall of 2008 (and spread throughout the world instantaneously), that could cause big problems for the United States Today, the danger zones aren't the stocks of JPMorgan Chase and Goldman. Rather, they're the esoteric market niches that became household words in the fall of 2008 and have since returned to obscurity. As CNBC notes, LIBOR (the London Interbank Offered Rate)—i.e., the rate banks charge to lend to one another—has risen for 11 straight days. While still low, the three-month LIBOR rate is the highest it has been since July 2009. The TED spread, the difference between interbank lending rates and rates on short-term U.S. government debt, has also popped up.

So far, the credit-market data suggest the virus of fear remains quarantined to Europe. But as we saw in the fall of 2008, contagion can be contagious.